Wednesday, July 16, 2008

Will we lose all our money?

Recently a U.S. bank failed. People waited in very long lines to get their cash out, and people with more than $100,000 might have lost all the rest of their money. Read about it here.

What does it mean for a bank to fail? A bank fails when a depositor tries to withdraw funds and finds that no funds are there to be withdrawn. This can happen because banks lend out much of the money the depositors deposit. If too many depositors try to take their money out at once, the money that the bank did not lend runs out before the borrowers pay back their loans to the bank.

Banks were failing a lot during the Great Depression. This inspired congress to create the Federal Deposit Insurance Corporation (FDIC). Nowadays, any bank that is not a member of the Federal Reserve System must pay insurance premiums to the FDIC so that the FDIC will protect the bank's customers from losing up to $100,000 in the event of a failure.

But what if a modern-day wave of severe bank failures causes the FDIC to run out of funds? Who insures the insurer? Since the FDIC is a federal (but somehow corporate) entity, it would, in the opinion of the Freakwenter, draw funds out of the US Treasury, running up the national debt.